Cryptocurrencies: Can They Be Used as an Investment Vehicle?
The popularity of Bitcoin and other cryptocurrencies continues to grow, but if you’re thinking about investing in them, there are some important things you should know first.
Beyond learning the basics of cryptocurrencies, investors should keep in mind the numerous risks that even the most popular cryptocurrencies are volatile, the market is not very transparent, transactions are irreversible, consumer protections are minimal or non-existent. We recommend that investors looking to invest in cryptocurrencies view them as a speculative asset using funds other than the traditional long-term portfolio.
Will Bitcoin or Other Cryptocurrencies Become the New Global Currency?
We don’t think so until proper regulations and consumer protections are in place, but time will tell. A currency usually requires three properties to be valid:
It can be used as an inexpensive, reliable medium of exchange;
It can be a unit of account;
It can be a store of value and legal tender, considered a means of payment.
As long as Bitcoin is subject to high volatility and high transaction fees, it seems likely that it will have only limited use as a medium of exchange, a unit of account, or a store of value. Another obstacle to the wider acceptance of the public as a real currency is the increased risk of regulation as cryptocurrencies become more prevalent.
Can Bitcoin Be Used as a Hedge Against Inflation?
Since the value of Bitcoin is not currently tied to the value of a basket of goods or services, its value as a means of inflation hedging is a matter of speculation and cannot be predicted. Throughout most of 2021 and 2022, Bitcoin has experienced both sharp rises and sharp price declines, although inflation data has been steadily higher. Whether Bitcoin will be an effective inflation protection in the long term has not yet been determined.
What Are Some Risks of Bitcoin and Cryptocurrencies?
Financial loss. Bitcoin and other cryptocurrencies have historically been highly volatile, and fluctuations can result in significant losses if sold at the wrong time.
Future editing. Cryptocurrency issuance and trading is currently not well regulated, and additional oversight and regulation is likely in the future. U.S. Treasury Secretary Janet Yellen has expressed concern about the use of cryptocurrencies “for illicit financing.”
Fraud and cybercrime. These have already occurred. Given the above concerns, cryptocurrencies could come under scrutiny from the Financial Crimes Enforcement Network (FinCEN) for failing to comply with the Bank Secrecy Act (BSA) and anti-money laundering requirements. Bitcoin exchanges have suffered computer outages due to excessive demand, and because ledgers are kept on the internet, a large-scale cyber attack could limit access in the event of an emergency; This is less likely with cash or gold.
Theft or loss. A login ID and password are usually required to access a cryptocurrency exchange. If this is lost, hacked, or stolen, access may be denied or lost. While unusual, bitcoins can be stored in physical wallets so they can be spent without a computer; This creates the same risks found in all cash: They can be lost, stolen, or destroyed by accident.
Does Schwab Recommend Investing in Cryptocurrencies?
In our opinion,
Bitcoin
, and other cryptocurrencies, are speculative investments. Since it is neither a traditional commodity like gold nor a traditional currency, we do not believe that Bitcoin currently fits into traditional asset allocation patterns. Bitcoin’s dramatic volatility is primarily due to supply and demand, not intrinsic value. Bitcoin has no earnings or revenue. There is no price-to-earnings ratio, price-to-sale ratio, or book value. Traditional value metrics are not valid, so there is no method for evaluating its value that we approve of or find convincing.
RESULT
Whether or not you invest in cryptocurrencies, as with any asset or security, depends on your goals and preferences as an investor. We recommend that clients approach this as a speculative investment and take into account the high volatility and risks involved. For those who already have a diversified portfolio and a long-term investment plan, we see ownership of cryptocurrencies outside of the traditional portfolio.
